The S-Corp is essentially the next step after the LLC. (Catch up on what these two terms mean in yesterday’s article.) As your business grows, it’s likely that many of us will need to move on from being an LLC to being an S-Corp. What does that mean? Well, the primary difference between these two business classifications is that an LLC owner doesn’t pay themselves a salary, and an S-Corp owner does. That single distinction can make a significant difference in the world of taxes, so let’s break it down.
We’re going to teach you how one form could help you save $3000 (or more!) a year in taxes.
Just bear with us—we’ll show you.
Scenario 1—You’re an LLC:
You’re registered as an LLC.
You are making $50,000 in profit annually.
Come tax time, you’ll have to pay income tax (this amount will vary on a lot of factors) and self employment tax (15.3%).
Scenario 2—You’re an S-Corp:
You’re an LLC and you’ve elected for S-Corp status (you’ve filled out Form 2553).
You are making $50,000 in profit annually (same as in Scenario 1).
You’ll first need to decide on a reasonable salary and start paying yourself through a payroll service (we love Gusto!).
Now when it’s tax time:
You pay yourself $30k as a salary (through payroll) and leave $20k as profit for your business.
On the $30k:
You pay both self employment and income tax on this amount.
On the $20k:
You can transfer these funds to yourself in “business distributions” throughout the year.
You will only pay income tax on this money, not self-employment tax (15.3%).
So...you save yourself $3060 a year in taxes on your business distributions by electing to be an S-corp. Nice, right?
Btw, you can’t cheat it and pay yourself a salary of $500 a month. It has to be a “reasonable salary” according the IRS. (salary.com gives you a good point of reference on this.)
Feels like wizardry—but it’s totally legit! All you need is form 2553.
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